Historic reform in Mexico clears the way for foreign investment in energy sector: 5 key aspects

Energy Alert

Latin America Alert

The energy reform proposed by Mexico’s Peña Nieto administration has been approved by the Mexican Congress and, in rapid succession, by a majority of the Mexican state legislatures. This sweeping, historic reform amends the Mexican constitution, clearing the way for foreign investment in the energy sector.

As we noted in our prior client alert on Mexican energy reform, A New Test for the Pacto por México: Energy Reform – Key Points for Energy Companies, unlike Mexico’s recent telecommunications reform, (which was very detailed and aimed to correct certain market conditions), Mexico’s energy reform is conceptual in nature. It leaves the details to the implementing legislation that is to come but, at the same time, provides a clear roadmap for the regulation of hydrocarbons. The reforms related to power and Mexico’s Federal Electricity Commission will be implemented as reported in our prior client alert.

Five key aspects of the constitutional reforms

The key aspects of the energy reform, which is expected to be published in the next few days in the Official Federal Gazette, are as follows:

1. The Mexican government will continue to control state-owned entities. The secondary, implementing legislation will provide for the administration, organization, operation, contracting processes and related actions of the State Production Companies (Empresas Productivas del Estado or SPCs). Petroleos Mexicanos (Pemex) will become just one of many SPCs and will compete with other SPCs and private parties (PPs).

2. No concessions. The Mexican state maintains the ownership of the oil and hydrocarbons in the subsoil. Midstream and downstream activities are open to PPs, subject, in some instances, to permitting.

3. SPCs that receive grants from the government or enter into contracts with PPs, and PPs that enter into contracts with the government or SPCs, will be permitted to report for accounting and financial purposes their grants or contracts and their expected benefits, provided that such grants and contracts specifically provide that any hydrocarbons found in the subsoil belong to the Mexican nation, ending the prior prohibition under Mexican law on the booking of reserves.

4. A yet-to-be-created trust called the Mexican Oil Fund will receive, administer and distribute all income other than taxes derived from such grants and contracts.

5. The Mexican state maintains the exclusive control of the national electrical system and the transmission and distribution power grid. There will be no concessions for the transmission or distribution of electrical energy, but PPs may participate in other power-related activities as further provided by the implementing legislation.

It will be incumbent on the Mexican Congress to take the following actions in connection with the implementing legislation:

Within 120 calendar days, Congress has been directed to enact laws to:

Regulate the manner in which exploration and extraction contracts may be granted, including (a) administrative grants to SPCs or (b) contracts with SPCs or PPs. The contracts with PPs may be: (i) services agreements, (ii) profit sharing agreements, (iii) production sharing agreements, or (iv) licensing agreements. The Implementing Legislation will specify the types of the consideration to be paid by the government (to SPCs or PPs), including: (i) cash payments for services contracts, (ii) a percentage of the profit for profit sharing agreements, (iii) a percentage of the production for production sharing agreements, (iv) the non-gratuitous transfer of hydrocarbons upon extraction for licensing agreements, or (v) any combination of the foregoing

Ensure that contracts are awarded through transparent processes, are available for public review (including of economic terms), and are subject to external auditing.

Regulate SPCs, including through the implementation of special framework for procurement, contracting, debt financing, financial requirements and related aspects.

Streamline the authority and power of the Ministry of Energy, the National Hydrocarbons Commission and the Energy Regulatory Commission.

Create a National Agency for Industrial Safety and Protection of the Environment of the Hydrocarbons Sector to primarily regulate health and safety and the environment in the hydrocarbon industry.

Prevent and provide sanctions for corrupt practices.

Within 365 calendar days, Congress has been directed to enact implementing legislation related to the environment and energy, including clean energy, which will:

Determine how and when Pemex will be converted into an SPC. In the meantime Pemex may receive grants of rights and enter into contracts.

Provide for local content requirements, to the extent permitted by international treaties.

Give preference to grants and contracts governing hydrocarbons over other rights of owners of the surface land (with appropriate economic compensation for landowners). Mining concessions will not grant concessionaires the right to exploitation of hydrocarbons.

Within 12 months from the enactment of the implementing legislation, the National Natural Gas Control Center (the “Energy Center”) will be created. The Energy Center will operate the national transport and storage system. Pemex will transfer to the Center its related assets, including contracts.

THE REGULATORS

The Ministry of Energy will:

Be responsible for energy policy

Issue grants

Select geographical areas for which contracts may be awarded

Design contracts and provide for technical guidelines relating to the bidding process

Grant of permits/licenses for the treatment and refining of hydrocarbons and processing of natural gas

The National Hydrocarbons Commission will:

Provide technical assistance to the Ministry of Energy

Compile geological and operational information

Grant surveying and surface-exploration authorizations

Conduct bid/auction processes

Determine winners of such processes and execute contracts

Administer the technical aspects of grants and contracts

Oversee extraction plans to maximize productivity

Regulate exploration and extraction

The Energy Regulatory Commission will:

Regulate and grant licenses for the warehousing, transportation and distribution through pipelines of hydrocarbons, natural gas and other oil byproducts, including ethanol, propane, butane and naphtha.

Regulate access by third parties to said ducts

Regulate first-hand sales of said products

The Ministry of the Treasury will:

Determine the economic considerations relating to bids/auctions

Determine the economic considerations relating to grants and contracts

ROUND ZERO: THE INITIAL ALLOCATION OF RIGHTS

The Ministry of Energy, with technical input from the Hydrocarbons Commission, will conduct an initial allocation of rights (“Round Zero”), in which it will grant Pemex, on a preferential basis, certain grants of exploration rights and rights to currently producing fields, subject to Pemex first providing evidence of its technical, financial and performance qualifications.

Pemex must apply for grants of rights to currently producing fields within 60 calendar days from the effective date of the constitutional reform. The Ministry of Energy (with technical input from the Hydrocarbons Commission) will act upon Pemex’s application within 180 calendar days. For exploration activities, Pemex will have up to five years from the effective date of the constitutional reform.

Pemex may apply for the migration of projects from grants of rights to contracts. It is not clear from the existing legislation how this will be implemented. Presumably this will be clarified in the implementing legislation.

The Ministry of Energy will specify the surface area, depth and term of each assignment, in order to permit the coexistence of different exploration or extraction projects and maximize productivity. When Pemex migrates a project from a grant to a contract, then, if Pemex wishes to contract with a PP for the provision of services with respect to such project, the Hydrocarbons Commission must conduct a bid process as specified in the implementing legislation. The Ministry of Energy will provide for the technical and contractual conditions, and the Ministry of the Treasury will determine the applicable tax regime.

After Round Zero, Pemex (and any other SPCs) will become just another competitor in the energy market and will be subject to competition from PPs and other SPCs.

THE MEXICAN OIL FUND

The Fund will be created in 2014 and will become operational in 2015.

The Fund will receive all income, other than taxes, due to the government with respect to grants and contracts, and will be responsible for the disbursements required under the grants and contracts, and other required disbursements. The trustee of the Fund will be the Central Bank.

Going forward, we will provide more information about the actions that businesses may take in light of this landmark change.

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DLA Piper is a global law firm with lawyers located in more than 40 countries throughout the Americas, Europe, the Middle East, Africa and Asia Pacific, positioning us to help clients with their legal needs around the world.

DLA Piper is a global law firm with lawyers located in more than 40 countries throughout the Americas, Europe, the Middle East, Africa and Asia Pacific, positioning us to help clients with their legal needs around the world.

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